What is a Binomial Tree? |Financial Risk Manager Training and Certification Video Lecture | Risk Management: An Essential Training - Management

simply learn your pace your place
financial risk manager frm par one of
the frm exam covers the fundamental
tools and techniques used in risk
management and the theories that
underlie their use by nominal trees
welcome to the 39th lecture in your
preparation for the frm exam in the
earlier modules we have learned about
options and their payoffs we have also
learned about the various trading
strategies involving options we will now
learn how to price the options using the
by nominal model the concept of pricing
an option utilizes the principles of by
nominal models that we are studied in
the section on probability and the
discounting of future cash flows if the
future cash flows from the options are
known then we can discount these cash
flows to present to obtain the option
price
agenda the agenda of our discussion will
focus on the various types of by nominal
models use for option pricing we will
learn about binomial models with one and
two periods these can be extended for
more than two periods in a modified
binomial model approach will include the
dividend yield from the option in the
case of American options which can be
exercised earlier we will find the
option prices as well as their pay us at
each period and determine whether or not
it is worthwhile to exercise early
accordingly the values are then
discounted back to the present to obtain
the option price binomial model concept
let us begin a discussion the binomial
model implies that they can only be two
outcomes of an event in our case the
price of the underlying follows a
binomial model that is the price can
either move up or down the probabilities
of movement are based on the assumption
of risk mutual valuation or the
assumption that the investors are risk
neutral the size of up and down
movements are given by the formula in
the slide which is e raised to the power
of the product of the standard deviation
and the square root of the time period
we use the sizes of up and down movement
to calculate the probabilities of up and
down movement which are given by the
formula in the slide the derivation of
this formula is beyond the scope of our
discussion and you must memorize these
formulas let us now apply these formulas
in a one-step binomial model to derive
the price of a cool option